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Challenges of Investing in Emerging Capital Markets: Integration vs. Segmentation

Paper presented by Global Investment House in the

Second Annual Palestinian Capital Market Forum

October 2008

Global Investment House October 2008

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Introduction Emerging markets have gained increasing attention in the global investor community, media, and academia in the last decade, so much that they have become a distinct asset class altogether. To an extent, this attention is justified. Emerging economies have been growing at roughly triple the rate of developed economies and currently account for around half of total world GDP measured at purchasing-power parity. This paper attempts to shed light on the characteristics of emerging markets with a particular focus on emerging market equities. Aided by extensive academic publications, the paper quantifies some of the unique features of emerging market equities and compares and contrasts those with developed market equities. The paper also addresses an issue that has come to the forefront of capital markets in the second half of 2008: capital market integration versus segmentation. Specifically, it takes an in-depth look at the prevailing trends in equity markets in the pre-liberalization stage and compares them to the prevailing trends in the post-liberalization stage, citing specific country examples. Finally, this paper attempts to apply some of the empirical work done on mainstream emerging equity markets to MENA equities, by comparing selected parameters across the Palestinian, Saudi and Egyptian equity markets. The results show that segmented MENA equity markets, like Palestine and Saudi, have lagged integrated MENA equity markets like Egypt, in terms of returns, but have experienced lower volatility and exhibited significantly lower correlation with global equity markets in the last decade. The paper concludes by recommending that fund managers overweight integrated equity markets / underweight segmented equity markets when global economic conditions are conducive, and do the opposite when the global economy is creating an overhang on global equities. I. Emerging Capital Markets: Definition & Classification Up until now, no universally accepted definition of an emerging market exists, nor does a consensus about which markets merit the “emerging” status. The composition of the emerging market universe is in a continual state of flux. Today’s emerging market may be tomorrow’s vibrant economy, thus, increasing the attractiveness and importance of these markets. In general, the term “emerging” implies the kind of growth and change that lead to investment opportunities as a result of improved economic, social, and political conditions. According to the World Bank, all countries classified as low or middle income countries are categorized as emerging market economies. These are countries with a 2007 gross national income (GNI) per capita of less than US$ 11,455. According to this definition, 144 economies fall into the developing category, however, only a handful of those countries merit the emerging title as the classification by income does not necessarily reflect development status. Standard & Poors (S&P) and the International Finance Corporate (IFC) define an emerging market as a market in transition, growing in size (market capitalization), activity (liquidity), or level of sophistication (modernizing and building market


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capacity). S&P/IFC classifies an equity market as “emerging” if it meets at least one of the following two criteria:

It is domiciled in a low or middle income economy as defined by the World Bank

Its investable market capitalization (foreign portfolio open to foreign investors) is lower than its recent gross national income figure

S&P/IFC added that equity markets which impose investment restrictions such as foreign ownership limits, capital controls, extensive government interest in listed stocks and other legal and political restrains on trading activity, particularly for foreign investors, are generally considered emerging markets. S&P/IFC notes “Pervasive restrictions on foreign portfolio investment should not exist in developed stock markets, and their presence is a sign that the market is not yet “developed”.” Moreover, Morgan Stanley Capital International (MSCI) developed a classification framework spanning the spectrum of market types, from Frontier, to Emerging and then to Developed Market. A new market accessible to international investors would logically start as a Frontier Market and evolve over time, if and when warranted, to Emerging Market status first and then to Developed Market status. In following this path, a market would need to comply with increasingly stricter standards in terms of:

Market accessibility (openness to foreign investment, investability, robustness and efficiency of the operational framework).

Company and security minimum size and liquidity, as well as minimum number of companies and aggregate size of eligible securities.

Sustainable characteristics of advanced economies and levels of geo-political risk

comparable to other existing Developed Markets, for achieving Developed Market status.

MSCI Index Constituents

MSCI Emerging Markets Index MSCI Frontier Markets MSCI Arabian Markets Argentina Malaysia Bahrain Romania Bahrain Brazil Mexico Bulgaria Slovenia Egypt Chile Morocco Croatia Sri Lanka Jordan China Pakistan Estonia Tunisia Kuwait Colombia Peru Kazakhstan Ukraine Lebanon Czech Republic Philippines Kenya UAE Morocco Egypt Poland Kuwait Vietnam Oman Hungary Russia Lebanon Qatar India South Africa Mauritius Saudi Arabia Indonesia Taiwan Nigeria Tunisia Israel Thailand Oman UAE Jordan Turkey Qatar Korea

Source: MSCI Barra Currently, the above shown MSCI classification framework is the benchmark for the fund management industry worldwide.


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II. The Case for Emerging Capital Markets The percent of the world’s population, output and capital market represented by emerging markets is steadily increasing. Emerging markets offer exciting growth prospects and have in recent years shown signs of de-coupling from developed economies. Although emerging markets are highly connected to the world in terms of goods flow, they are not fully connected in terms of financial flows, reducing their exposure to global turmoil and exogenous shocks. The output of emerging economies is reaching an important milestone: it accounted for around half of total world GDP measured at purchasing-power parity1. This means that the rich countries no longer dominate the global economy and the developing countries have a far greater influence on the performance of the rich economies than history has shown. Emerging economies are driving global growth and having a big impact on developed countries' inflation, interest rates, wages and profits. As these newcomers become more integrated into the global economy and their incomes catch up with the rich countries, they are expected to provide the biggest boost to the world economy since the industrial revolution.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

FX Reserves (US$bn)

Land Mass (sq. km)

Energy Consumption (mn toe)

Exports (US$bn)

GDP at PPP (US$bn)

GDP at market rates (US$bn)

Population

Emerging Economies Developed Economies

The GDP of emerging market countries as a group has been growing at roughly triple the rate of developed economies GDP in recent years. For example, in 2007, the real GDP of emerging countries grew 7.9 percent compared to 2.7 percent for developed countries. Growth in emerging and MENA markets is projected to be 6.7 percent and 6.2 percent for 2008, respectively, while developed markets are expected to witness a major slowdown in the next couple of years. This lends support to the argument of decoupling between developed and emerging economies.

1 Purchasing power parity (PPP) means that goods and services should cost the same in all countries when measured in a common currency. It is the exchange rate that equates the price of a basket of identical traded goods and services in two countries. Using a GDP at PPP basis is arguably more useful as it takes into account the relative cost of living and the inflation rates of the countries.

Source: Merril Lynch Estimates


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Real GDP Growth (%)

0%

2%

4%

6%

8%

10%

2003 2004 2005 2006 2007 2008E 2009F 2010F 2011F 2012F 2013F

Developed Markets Emerging Markets MENA Markets

Empirical evidence has shown a positive relationship between stock market performance and economic growth2. It has been found that various measures of stock market activity are positively correlated with measures of real economic growth across countries, and that the association is particularly strong for developing countries. The importance of emerging capital markets is increasing relative to global capital markets, as the share of emerging markets in world market capitalization has increased from 9.35% at the end of 1997 to 19.3% in 2006. Moreover, the market capitalization of emerging market countries has more than doubled over the past decade, growing from less than $2 trillion in 1995; it is set to exceed $5 trillion in 2008.

1997

9.35%

90.65%2006

19.30%

80.70%

2 Levine and Zervos (1998)

Source: International Monetary Fund

Emerging Market’s Share of World Market Capitalization

Source: S&P Global Stock Markets Factbooks


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III. Characteristics of Emerging Equity Market

Returns Emerging markets are playing an increasingly important role in international portfolios. A major argument for investing in emerging markets is their growth prospects, high average returns, high volatility, and low correlations both across the emerging markets and with developed markets. Although emerging markets have exhibited higher volatility historically, they have provided a significantly higher return over the last ten years. In fact, the MSCI emerging markets index has outperformed the MSCI world index significantly, posting a compounded annual growth rate of return of 12.73% versus 5.43% for the world index over the last 10 years.

Value of $100 invested on Jan 1, 1998

-

50

100

150

200

250

300

350

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

MSCI Emerging Markets MSCI World

Volatility As can be seen, the volatility of emerging markets is much higher than that of developed markets. For example, during the past 10 years, the volatility (annualized standard deviation) is 20.69% for the emerging index compared to 14.06% for the world index. However, when comparing the expected returns to the amount of risk undertaken, the results reveal that the emerging market stocks provided higher rates of return than developed market stocks after adjustment for risk. Calculated using monthly data, the reward-to-risk ratio of emerging markets stands at 0.62 relative to 0.39 for developed markets, showing significant outperformance on a risk adjusted basis. Emerging market returns depart from normality as the distribution of returns is not symmetric, and the probability of a large price movement is higher than would be the case if the distribution of returns were normal. Emerging market returns have more positive skewness than developed market returns. Positive skewness means that there are more frequent large positive returns than there are large negative returns. In other words, large positive outlier returns occur more frequently than large negative outlier

Source: Reuters


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returns, indicating a bias to the upside. Similarly, emerging markets present more excess kurtosis than the world benchmark. It is reasonable to expect that investors prefer more positive skewness and excess kurtosis.

The departures from normality imply that the usual mean-variance framework is no longer adequate to characterize investment decisions. Hence, the standard deviation is not a sufficient measure of market risk. Investment risk in emerging economies often comes from the following sources: a) Political Reform and Liberalization: some emerging countries do not have a fully

stable political and social situation, and the explosive social transformation brought about by rapid, and sometimes anarchic, economic growth can lead to serious imbalances, causing social and political unrest.

b) Infrastructure: infrastructure can limit growth; also education structures are often

insufficient to train a large number of workers and managers in modern international techniques.

c) Corruption: Corruption is a rampant problem everywhere but may be more present

in some emerging countries. Family ownership tends to favor family and friends at the detriment of other shareholders, especially foreign ones. Also links between politicians and companies’ managers sometimes go beyond what would be in the interest of shareholders.

d) The banking sector is sometimes poorly regulated, unsupervised, undercapitalized

for the lending risks assumed, and lacking in the sophistication required by modern financial operations.

Correlation Emerging markets exhibit a positive but moderate correlation with developed markets; the correlation with the world index of developed markets is around 0.8. Hence emerging markets can have a positive contribution in terms of risk-return trade-offs. Integrated markets have been found to exhibit relatively high correlation with global equity markets. Our correlation matrix supports this notion, showing that MSCI BRIC and Emerging indices are highly correlated with MSCI World, whereas MSCI

Positive Skew Excess Kurtosis


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Arabian index exhibits a much lower correlation with the World index. It is safe to assume that BRIC countries are far more integrated than Arabian markets in the global capital market.

Correlation Matrix MSCI Arabian MSCI BRIC MSCI

Emerging MSCI World

MSCI Arabian 1.00

MSCI BRIC 0.38 1.00

MSCI Emerging 0.30 0.95 1.00

MSCI World 0.16 0.78 0.83 1.00 Correlations are based on 5 year monthly returns International correlation tends to increase in periods of crises, and emerging markets are subject to periodic large crises. Moreover, crises on emerging markets tend to be more prolonged than crises on developed markets, and tend to spread to all emerging markets in the region Correlations between global equity markets have become more pronounced as global capital markets are becoming more integrated and liberalization is becoming more effective.

Correlations with MSCI World Index

(0.20)

-

0.20

0.40

0.60

0.80

1.00

2003 2004 2005 2006 2007 2008

MSCI Emerging MSCI BRIC MSCI Arabian

Correlations are based on 5 year monthly returns Currency Risk: The correlation between stock and currency returns is worth observing. Developed markets sometimes exhibit a negative correlation with the value of their currencies; the local stock market tends to appreciate when the value of the local currency depreciates. The argument is based on an improvement in the international competitiveness of the local firms, which is not the case for emerging stock markets where both the stock market and the currency are affected by the state of the economy. This positive correlation implies that foreign investors suffer doubly from currency risk in emerging markets.


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IV. Challenges of Investing in Emerging Capital Markets Investability of Emerging Markets Many restrictions are imposed on foreign investors when it comes to investing in emerging capital markets. Although many emerging countries are very liberal toward foreign capital, investability is somewhat restricted in other countries. Restrictions can take many forms: a) Foreign ownership can be limited to a maximum percentage of the equity capital

of companies listed on the emerging market b) Free float is often small because the local government is the primary owner of

many companies which leaves the float available to foreign or domestic private investing limited

c) Repatriation of income or capital can be somewhat constrained (such capital flows

have been liberalized in most emerging countries, but controls are periodically applied in periods of severe crisis)

d) Discriminatory taxes are sometimes applied to foreign investors, although this is

becoming exceptional e) Foreign currency restrictions are sometimes applied f) Authorized investors are the only investors allowed to invest in some emerging

countries, where these authorized foreign investors are typically institutional investors as opposed to foreign retail investors

Providers of emerging market stock indices have tried to reflect the investability of markets by constructing “investable” or “free float” indices, where foreign ownership restrictions and free float strongly affect the weight of a given emerging country in the index. Market Illiquidity Emerging markets are relatively illiquid and the transaction costs of investing in these markets are sometimes significant relative to developed markets. Market liquidity varies considerably across emerging markets as some markets exhibit liquidity levels typical of developed markets, but most emerging markets exhibit substantially lower liquidity levels. Since investors require higher returns in markets that experience greater illiquidity, emerging market illiquidity premiums tend to be high and tend to decline once the market is opened up to outside investors. Information Inequities Various aspects of this information asymmetry are:


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a) Insider Trading: information environment in emerging markets may deviate from the assumptions of the semi-strong form of the Efficient Market Hypothesis (EMH). For some classes of stock, material corporate news announcements are generally associated with no change in stock prices. This behavior can be explained by earlier insider trading by those who posses material nonpublic information.

b) Domestic versus Foreign Information Advantage: local investors in emerging

markets naturally have an information advantage over foreigners. On the other hand, foreign investors sometimes tend to outperform locals in their stock selection and timing in emerging market investing

c) Financial Disclosure: a major reason for information inequities among investors in

emerging markets is arguably a lack of transparency of earnings disclosure resulting from either poor accounting standards, perverse managerial motivations, and/or lack of enforcement (e.g., credible auditing)

Under pressure from international investors, emerging markets are becoming more efficient, providing more rigorous research on companies and progressively applying stricter standards of market supervision. Accounting standards that conform with International Accounting Standards (IAS) have been adopted in many countries and are progressively implemented.

Risk and Return Measurements The applicability of widely used financial models in emerging markets has long posed a challenge in finance. Standard models are often ill suited to deal with the specific circumstances arising in these markets. For instance, the Capital Asset Pricing Model (CAPM) relies upon the assumption that investors have mean-variance preference which in turn implicitly assumes that return distribution is symmetrical; however, as previously mentioned, most of the returns in emerging markets have been found to be non-normal. Moreover, the CAPM is not an appropriate model if emerging markets are not integrated into world capital markets. In integrated capital markets, assets with identical risk should command identical expected returns, irrespective of domicile. Provided that many of the emerging capital markets are not integrated into world capital markets, the beta suggested by the CAPM may not be that useful in explaining average expected returns. Other problems most discussed in international corporate finance is the measurement of an appropriate discount rate to use in evaluating investment projects in emerging markets, which poses a significant challenge to multi-national companies and investors of emerging markets.


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V. Integration versus Segmentation Across the globe, capital markets are becoming more integrated, and this increasing integration is particularly evident in emerging markets. Segmented Markets: A segmented market is a market in which there are impediments to the free flow of capital and the expected returns on similar assets domiciled in different countries do not exhibit a statistically significant correlation. Returns on local companies are strongly influenced by domestic variables rather than global variables. Also domestic risk in these assets is priced as opposed to global risk. The pricing of expected asset return should be proportional to local risks, however, local volatility is much higher than the contribution of the asset to the world market risk (its beta). Hence, expected returns in segmented markets should also be higher. Segmented asset pricing tends to be attractive to the global investor as it implies that assets are mispriced relative to their international value. Integrated Markets: An integrated market is one in which there are no barriers to financial flows, and assets with identical risk should command identical return, irrespective of their domicile. Liberalization should bring about emerging market integration with the global capital market. A liberalized equity market is that foreign investors can, without restriction, purchase or sell domestic securities. The integration assumption implies that risk in integrated emerging markets can be effectively defined as beta with the world. Transition from segmented to integrated state The process of financial liberalization is time varying and not a one off event. This creates difficulty in pin pointing the exact date of liberalization. In addition, removals of regulatory restrictions may not attract foreign investments in the presence of other indirect barriers and emerging market specific risks. These complexities cause difficulties in the development of dynamic models for pricing securities in emerging markets and measuring the impact of integration. The implications for capital markets as they evolve from the segmented to the integrated state are as follows: a) Market prices may react upon announcement of liberalization or as soon as

investors anticipate it, and not necessarily upon the actual flow of foreign funds. Historically, there has been a delay between the announcement of liberalization and the authorization of actual foreign investment by governments. Hence, foreign investors may not be able to enjoy the higher return experienced by local investors because the capital begins flowing only after the ‘return to integration’ (the initial price jump due to integration measures) has occurred and capital flows may see a decline as a result (see diagram below).


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b) Higher degree of integration should reduce cost of equity capital (expected

return). The rationale is that the volatility of segmented market returns is much higher than their covariance with world market returns. As markets integrate with the world economy, the systematic risk becomes global. Holding other factors constant, the implication is that as markets become more susceptible to global sources of risk, the local variance decreases accompanied by increase in the covariance with world market portfolio. Since the world market portfolio is assumed to be less volatile than local market portfolio, this further reduces the cost of capital and pushes up prices and valuation.

c) Some structural changes may be observed in the market. For example, companies

will be encouraged to go public as the cost of capital decreases, which will reduce market concentration and increase depth.

d) Liberalization has been empirically associated with an increase in local market

liquidity e) As individual stocks may become less sensitive to local information and more

sensitive to world events, cross-correlation of individual stocks within the market may change.

f) Announcement or measures initiated to bring about integration do not necessarily

attract foreign investments due to legal barriers (e.g. foreign ownership restrictions and taxes), indirect barriers (e.g. differences in available information, accounting standards, and investor protection), and barriers arising from emerging market specific risks (e.g. liquidity risk, political risk, economic policy risk, and currency risk) that discourage foreign investments and lead to de facto segmentation

Source: Bekaert and Harvey (2003), Emerging Markets Finance, Journal of Empirical Finance, p.7


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Effects of Market Integration Bekaert and Harvey (2003) measured the impact of liberalization on 20 emerging equity markets. Due to the complexity of the liberalization process, they define capital market liberalization using three alternative measures: official regulatory liberalization, the announcement of first American Depository Receipt (ADR) issue, and the first country fund launching. Tracing the impact of equity market liberalization on risk and return, they observed the following:

Returns: average returns decrease after financial liberalization.

Volatility: There is no significant impact on volatility. On the one hand, markets may become more efficient leading to higher volatility as prices quickly react to material information. On the other hand, in pre-liberalized markets, there may be larger swings from fundamental values leading to higher volatility, and as markets integrate, gradual development and diversification of the market should lead to lower volatility

Correlation & Beta: correlation and beta with the world market increase after

equity market liberalization

Impact of Equity Market Liberalization on Returns

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

Avg Annual GeometricReturns

Avg Annualized StandardDeviation

Correlation with World Beta with World

Pre Post

Source: Bekaert and Harvey (2003) VI. Integration & Segmentation in a MENA Context In this section, we attempt to capture some of the theoretical and empirical underpinnings observed in global equity markets on MENA equity markets. We compare volatility and correlations to global equities across the following markets:

The Saudi Stock Exchange: the Tadawul is our base case for a segmented MENA equity capital market

The Egyptian Exchange: the EGX is our base case for an integrated MENA equity

capital market


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The Palestine Securities Exchange: the PSE is our extreme case segmented

MENA equity capital market Given the lack of sufficient data on the above markets, it is difficult to conduct a pre and post liberalization analysis of each market. Instead, we opt to compare segmented MENA equity markets (Saudi and Palestine) with integrated MENA equity markets (Egypt). For Saudi, we believe the market remains a classic case for a segmented equity market, despite recent developments that have opened the door for GCC investors and more recently the initiation of equity swap agreements on specific stocks. Foreign, non-GCC investors are still unable to directly access the Saudi market, and most do so indirectly through investing in funds. It is difficult to pin-point the exact date of liberalization for a stock market like Egypt’s and hence we chose not to conduct a pre and post liberalization analysis. However, we believe Egypt’s equity market is the most integrated of all MENA markets, including Dubai where caps on foreign investments are still in place for some stocks. For Palestine, we acknowledge that the market is legally open to foreign investors, but in effect the market in our opinion remains segmented as a result of political risk. Our analysis has revealed the following:

Returns All else equal, the net effect of foreigners has been very positive to equity markets in our MENA sample over the last decade. Egyptian equities, our integrated example, posted an annual growth rate of 29.9%, significantly outperforming Saudi and Palestine which represent our segmented examples. Moreover, the Saudi equity market slightly outperformed the Palestine equity market, and we partly attribute this outperformance to stronger foreign investment in Saudi compared to Palestine in the last decade. However, the foreign investor effect has also been prevalent on the downside, especially in 2008. The major re-rating in Egyptian equities in 2008 has been almost exclusively led by net selling on the part of foreign funds and institutions, and was exacerbated by retail investors who tend to be followers of foreign investors. Palestine, being a segmented market, did not see a similar trend to Egypt, and the year-to-date decline in Saudi equities has largely been caused by domestic factors.


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Value of $100 invested on January 1, 1999

0200400600800

1,0001,2001,4001,6001,8002,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Palestine Saudi Egypt

Volatility Our results show that Palestine is the most volatile market over the last ten years compared to Egypt and Saudi. Egypt and Saudi support our conviction that segmented markets (Saudi) are less vulnerable to exogenous shocks than are integrated markets (Egypt). For Palestine, we believe that 10 year volatility is skewed by a one-off year in 2005.

Overall, our results show that segmented MENA equity markets have exhibited lower volatility than their integrated counterparts based on our three market sample.

Returns Volatility (10 years)

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%

Saudi

Egypt

Palestine

Annual Standard Deviation

0%

10%

20%

30%

40%

50%

60%

70%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Palestine Saudi Egypt

10 year volatility in Palestine is skewed by a one-off year in 2005 when Al-Quds index appreciated by 307%

CAGR (Egypt) 29.9%

CAGR (Saudi) 17.6%

CAGR (Palestine) 15.8%


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Correlations with MSCI World

We examine correlations of returns of Saudi, Egyptian, and Palestinian equity indices against the MSCI World index. Theory and empirical evidence applied to emerging markets have shown that correlations with global equities increase post liberalization.

Our results are consistent with empirical evidence done on other emerging markets. Based on 10 year monthly correlations, we find that correlations are significantly higher in Egypt than they are with either Saudi or Palestine.

Correlations with MSCI World (1998 - 2008)

0.00

0.10

0.20

0.30

Al Quds Index Saudi All Shares Index CASE 30 Index

If we narrow down our correlation period to the last five years, we even find negative correlations in Saudi and Palestine, and even more pronounced correlation in Egypt.

Correlations with MSCI World (2003 - 2008)

-0.05

0.05

0.15

0.25

0.35

Al Quds Index Saudi All Shares Index CASE 30 Index

Based on the results of our analysis, MENA-oriented fund managers may be inclined to increase their allocation toward segmented equity markets and reduce allocation toward integrated equity markets when they expect exogenous shocks to the global financial system to increase. Year-to-date, this strategy would have held correctly in Palestine (overweight – YTD = +25.2%) and Egypt (underweight YTD = -29.7%). However, in Saudi, we believe local market factors have dominated on the downside (overweight YTD = -34.6%).


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Conclusion The attention given to emerging markets in the last decade is warranted and their categorization as a distinct asset class may be appropriate. After all, emerging equities have been shown to exhibit an entirely different risk-return profile relative to developed equities, and bring to the table a host of unique characteristics including information asymmetry, liquidity constraints, varying corporate governance standards, etc. Historical results point to a significant difference in equity returns, volatility, correlations, and world beta in the pre and post capital market liberalization stages. Most notably, average returns have been found to decrease after financial liberalization, correlation and beta with the world market increase after equity market liberalization, and the net impact on volatility not significant. In a MENA context, our analysis and results were more or less consistent with observations seen in other emerging markets. The net effect of foreigners has been very positive to our integrated equity market (Egypt) in our MENA sample over the last decade in terms of equity market returns. Volatility was higher in our integrated MENA equity market compared to our segmented MENA equity market, with the exception of Palestine which we argued was affected by 2005. Finally, correlations with global equities were far more pronounced in Egypt than they were in Saudi and Palestine. Our results put forth a strong case for fund managers to underweight integrated / overweight segmented MENA equity markets when global equity markets are in turmoil, and take an opposite position when conditions are conducive to global equities.


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References Bekaert, Geert, and Campbell R. Harvey, 2003, “Emerging Markets Finance,” Journal of Empirical Finance, Vol. 10, nos. 1-2, pp. 3-56 Bekaert, Geert, Campbell R. Harvey, and Robin L. Lumsdaine, 2002, “Dating the Integration of World Equity Markets,” Journal of Financial Economics, Vol.65, no. 2, pp. 203 - 247 Bekaert, Geert, Claude B. Erb, Campbell R. Harvey, and Tadas E. Viskanta, 1998, “Distributional Characteristics of Emerging Markets Returns and Asset Allocation,” Journal of Portfolio Management, Vol. 24, pp. 102-116 Levine, Ross and Sara Zervos, 1998, “Stock Markets, Banks, and Economic Growth,” American Economic Review, Vol. 88, pp. 536-558 Schill, Micheal J., 2006, “New Perspectives on Investing in Emerging Markets,” The Research Foundation of CFA Institute, Emerging Markets (May 2006) Solnik, Bruno, and Dennis Mcleavey, 2003, “Chapter 9: The Case for International Diversification in International Investments,” Addison Wesley, 5th edition Taskin, Fatma and Gulnur Muradoglu, 2003, "Financial liberalization: from Segmented to Integrated economies," Journal of Economics and Business, Vol. 55, no. 5, pp. 529-555

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